UK: High Court Rules That Tax Relief is Available for Abortive Takeover Costs

Last Updated: 18 July 2003

It is now clear that companies can deduct upfront the professional fees associated with preparing an abortive bid for another company. This is the effect of the High Court decision in Camas plc v Atkinson, published last week.

The Camas decision contradicts the Revenue’s position, based on the Irish case of Hibernian Insurance Company, that there is no tax relief for the costs of an abortive bid. In practice some companies have been able to negotiate a deduction for at least part of these costs but it is helpful that UK law in this area has been clarified in the taxpayer’s favour.

The case may also apply to similar costs incurred in successful bids, in relation to the acquisition of other investments, such as real estate and on group restructurings.

What happened in Camas?

Camas plc ("Camas") is the listed holding company of the Camas group. The group’s main activities are quarrying and the manufacture of asphalts and pre-cast concrete products. In early 1995 Camas was looking to acquire new investments in the same market sector and, in March of that year, identified Bardon Group plc as a possible target for either merger or acquisition.

During the rest of that year, Camas incurred over £0.5m in professional fees with the twin aims of deciding whether Camas should launch a bid and preparing the documentation which must be issued if a bid is made. As is the case with all potential public offers, the timing constraints were such that an extensive level of preparation was required before any decision had been taken on whether to make an offer.

Between April and August 1995, representatives of Camas had various meetings with Schroders, their principal City advisers, to discuss the feasibility of a merger with or acquisition of Bardon. In early September, the Chairmen and Chief Executives of both groups met and agreed that the "industrial logic" for a merger existed.

By late October, Bardon’s share price had fallen significantly and the board of Camas decided that acquisition by recommended offer was the preferred route. External advisers (brokers, lawyers and accountants) were instructed to commence "background technical work".

Camas made an offer on 19 December which was rejected by the Bardon board. The following day Camas decided that there was no possibility of a recommended bid at a price which it was prepared to offer and that the prospects of success for a hostile bid were too uncertain to warrant proceeding. "Project Bardon" was therefore abandoned.

The professional fees

The costs incurred by Camas in connection with Project Bardon included fees for:

  • Financial advice on the possible takeover
  • Legal advice on directors’ duties and competition aspects
  • Preparation of reports on working capital and possible synergies of a combined group
  • Negotiation of finance facilities
  • Analysis of possible Bardon shareholder reaction to a hostile bid
  • US anti-trust and securities law advice
  • Printing of offer documentation, listing particulars and circulars to shareholders

Camas sought to deduct all the costs associated with Project Bardon as "management expenses". The Revenue rejected this claim, other than in respect of the fees associated with the finance facility. These were allowable under the separate rules granting tax relief for the incidental costs of obtaining loan finance.

Tax relief for expenditure

The way in which tax relief is given for expenditure depends on whether a company is a trading company or an investment company. Being the holding company, Camas is an "investment company" within the meaning of section 130 Taxes Act 1988. An investment company is a company whose business consists wholly or mainly in the making of investments from which the principal part of its income is derived.

Expenditure incurred by an investment company is relieved in one of two ways:

  • As management expenses under section 75 Taxes Act 1988; or
  • Under the chargeable gains code as acquisition expenditure, including incidental costs of acquisition, under section 38 Taxation of Chargeable Gains Act 1992.

Management expenses treatment is more advantageous for the taxpayer because tax relief is given upfront in the accounting period in which the sums are disbursed. By contrast, relief under the chargeable gains code is given only when the underlying asset is disposed of. The acquisition cost and incidental costs of acquisition are deducted from the disposal proceeds in computing the company’s chargeable gain. No relief is given under the chargeable gains rules if the disposal of the investment is exempt under the substantial shareholdings rules. There is also no possibility of tax relief under the chargeable gains rules if the acquisition does not proceed.

"Management expenses"

The issue in Camas was whether the costs incurred by Camas were management expenses. If they were not, no tax relief would be available at all to Camas, given that the acquisition did not proceed.

The leading case on the meaning of "management expenses" is the House of Lords decision in Sun Life Assurance Society v Davidson 1958. It was the correct interpretation of the Sun Life case which was at issue in Camas. The following principles can be derived from Sun Life:

  • Management expenses can be either capital or revenue. Expenses associated with a bid or possible bid would normally be capital but this does not of itself prevent such costs from being deductible as management expenses
  • The concept of management expenses is to be interpreted broadly
  • Expenditure in relation to investment will be a management expense only if it is "severable" from the acquisition cost of the underlying investment and not part of the cost of acquisition

The Special Commissioners – costs were not management expenses

It was the application of the severability test which caused difficulty in Camas. The Special Commissioners held that the fees incurred by Camas were part of the acquisition cost and thus not management expenses because the expenditure was "directed at" the possible acquisition of Bardon and Camas could not have made an offer without incurring the expenditure. It was irrelevant that no acquisition actually took place. Camas appealed successfully to the High Court.

High Court – costs of abortive bid are Deductible

The High Court held that the Special Commissioners had misapplied the Sun Life test. All the fees incurred by Camas were "necessary and payable regardless of whether the purchase took place". This meant that they were severable from the cost of acquisition and thus deductible as management expenses. On the other hand, success fees, stamp duty and brokerage costs which would only be payable if the acquisition actually took place were not severable from the cost of acquisition and would not therefore be management expenses. Relief would only be available for these costs, if at all, under the chargeable gains code when the investment was ultimately disposed of.

The High Court decision is clearly advantageous to the taxpayer as it makes clear that upfront tax relief is available for the costs associated with an abortive bid. Brief reference was made to the recent Irish Supreme Court decision in Hibernian Insurance Company, which held that these costs do not constitute management expenses. This case, whilst not technically binding in the UK, has been relied on by the Revenue to deny deductibility of takeover costs. The High Court considered that the Irish Supreme Court had not applied the Sun Life "severability" test correctly.

The Revenue has not yet indicated publicly whether it intends to appeal against the High Court decision.

What about the costs of unsuccessful bids?

No bid was formally launched by Camas. If a bid had been launched but the bid was unsuccessful, would the position be any different?

The decision in Camas, drawing on statements made in Sun Life, makes it clear that fees for professional services which enable a company to determine whether or not to make an acquisition are deductible management expenses. It follows that all fees incurred up to the point where a decision is made to launch a bid should qualify for deduction. It is also arguable that fees incurred after that point in connection with a decision to withdraw or alter a bid should also qualify as management expenses, as they relate to an ongoing decision-making process.

Does the same reasoning apply to costs of a successful bid?

The same tax treatment of professional fees should also apply where a bid is successful. Clearly, it is easier to argue that expenses are severable from the costs of acquisition, if no acquisition ever takes place. However, a successful bid will always be preceded by an investigation process leading up to a decision on whether to make an offer. All professional fees incurred up to this point should be deductible management expenses. The Camas decision says as much:

"even if the acquisition had gone ahead, the nature of the services would have been the same. Although one element of the professional services involved the working-up of the bid, [the expert] evidence indicated that this was part of the decision-making process… I am unable to see how the cost of any of this can fairly be described as the cost of acquisition in the sense that brokerage fees, payments for finance and stamp duty obviously are.."

Does Camas apply to the acquisition of unlisted companies?

The Camas case concerned a possible bid by a listed company for another listed company. However, there is no reason why it should be restricted to this situation. Expenditure incurred on advice and investigation work in relation to a possible acquisition of an unlisted company (by either a listed or an unlisted company) should also qualify for deduction as management expenses until a decision is made to proceed with the acquisition.

Does Camas apply to other types of transaction?

There appears to be no reason why Camas should not apply to professional fees incurred in relation to the acquisition or possible acquisition of other types of investment, such as real estate and, prior to 1 April 2002, intellectual property. If such costs are "severable" from the acquisition cost of the underlying asset (that is, incurred before a decision to proceed with the acquisition is made) they should be deductible as management expenses, provided they are incurred by an investment company.

Similarly, professional fees associated with group reorganisations, demergers and restructurings to return value to shareholders should also be relievable as management expenses until a decision is taken to proceed with the relevant transaction.

It is worth noting that investment companies may be in a more advantageous position than trading companies in terms of claiming tax relief for costs associated with an investment or possible investment. Trading companies can only claim tax relief for revenue costs. Capital expenditure is not generally deductible and the costs associated with a bid or other proposed investment will normally be capital. Groups should therefore ensure that these costs are incurred by an investment company rather than a trading company (or a company which is neither).

What should taxpayers do now?

Investment companies which have had this type of expenditure disallowed in the past (or have not claimed a tax deduction in respect of it) should consider seeking to amend their corporation tax computations for the relevant years. This is subject to the normal CTSA time limits.

Article by Emma Nendick

© Herbert Smith 2003

The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

For more information on this or other Herbert Smith publications, please email us.

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